Class 2: The Business Model

MG106 Strategic Management

José Ignacio González Rojas

London School of Economics and Political Science

June 25, 2025

Today’s Focus

The Business Model Framework

WHO Who is the paying customer?
WHAT What value do we offer?
HOW How do we create and deliver it?

Every business is a unique WHO-WHAT-HOW combination

Your Mission

Four Questions to Explore

  1. What was Blockbuster’s business model?
  2. What was Netflix’s entry strategy?
  3. How did Netflix evolve its model?
  4. Why did Blockbuster’s response fail?

You have 15 minutes to discuss ALL questions with your group

Discussion Time

Use the WHO-WHAT-HOW framework

Let’s Explore Together

Question 1: Blockbuster’s Empire

What did you discover about their model?

WHO did Blockbuster serve?

What about their offering?

WHAT did customers get?

And their delivery method?

HOW did they operate?

Blockbuster’s Model Revealed

WHO

  • Impulse renters
  • “Movie night” families
  • Convenience seekers

WHAT

  • Latest releases (70%)
  • 2-3 day rentals
  • Late fees ($600M/year)

HOW

  • 9,000+ stores
  • “10-minute drive”
  • Part-time staff

This model printed money… until it didn’t

Question 2: Netflix Enters

What was Netflix’s initial approach?

How did they answer WHO-WHAT-HOW?

The Key Question

Was Netflix cheaper than Blockbuster?

Was it more convenient?

So why would anyone use it?

Netflix 1.0: The Reality

The Model

  • WHO: DVD early adopters
  • WHAT: DVDs by mail, $4 + $2 shipping
  • HOW: Website + USPS

The Problem

  • Same price as Blockbuster
  • 3-5 day wait each way
  • Still had late fees
  • Tiny DVD selection in 1997

This model FAILED spectacularly

The Customer Experience

“Why would I wait when Blockbuster is down the street?”

Question 3: The Evolution

What changes did Netflix make?

Think about each version…

What customer problem did they solve?

The Big Innovation

What was revolutionary about

“unlimited rentals, no late fees”?

Evolution Timeline

1997 - FAILURE
📀 DVD by Mail • $4 + shipping • Late fees

1999 - BETTER
📀 Subscription Model • 4 movies/month • Prepaid

2000 - BREAKTHROUGH
🎯 Unlimited Plan • 3 at a time • NO late fees

2001 - DOMINATION
🚀 Distribution centers • Overnight delivery • Recommendations

The Breakthrough Moment

Version 3: The Game Changer

The Innovation

  • Unlimited rentals
  • NO late fees
  • Keep 3 movies at home
  • Swap anytime

Customer Psychology

  • “Movies always available”
  • No pressure to watch
  • No penalty for life getting busy
  • Feels like ownership

They turned the disadvantage of delivery time into an advantage

Two Hidden Weapons

What else did Netflix develop?

Think about:

  • How did they recommend movies?
  • How did they improve delivery?

The Complete Arsenal

Recommendation System

  • Personalized suggestions
  • Filtered out unavailable titles
  • 70% rentals from back catalog
  • ¾ star higher satisfaction

Distribution Network

  • Started: 1 center (Sunnyvale)
  • Expanded: 44 centers by 2007
  • Result: 90% overnight delivery
  • Game-changing convenience

Both innovations reduced costs AND improved service

Question 4: Blockbuster Strikes Back

When did Blockbuster respond?

What did they do?

Why do you think it failed?

The Critical Question

Could Blockbuster afford to match Netflix?

Think about their cost structure…

The Timeline of Denial

2002: “Online rental serves a niche market”

2004: Finally launches Blockbuster Online

2005: Eliminates late fees (loses $600M revenue)

2007: Total Access (online + stores)

2010: Bankruptcy

What went wrong?

The Fatal Flaw

Blockbuster’s Impossible Math

Cost Structure

  • 9,000 stores = massive rent
  • 60,000 employees
  • Inventory in every location
  • Can’t close stores (Total Access)

The Dilemma

  • Match Netflix = lose money
  • Keep prices high = lose customers
  • Close stores = lose identity
  • Result: No way to win

Different business models have different economics

Let’s Compare

How would you summarize the differences?

Think WHO-WHAT-HOW…

The Final Comparison

Blockbuster Netflix
WHO Impulse renters Movie enthusiasts
WHAT Instant gratification Unlimited entertainment
HOW Physical stores Distribution + algorithms
Revenue Rental + late fees Subscription
Cost Base High (stores) Low (warehouses)
Inventory Distributed Centralized

Same industry, completely different games

Key Lessons

1. Business Models Evolve

Netflix transformed 4 times in 4 years

Each change solved a specific customer problem

2. Question Everything

Blockbuster’s Assumptions

  • Movies = impulse purchase ❌
  • Customers need instant access ❌
  • Late fees are acceptable ❌

Netflix’s Questions

  • What if people planned movie watching? ✓
  • What if “always available” > “right now”? ✓
  • What if no late fees = more rentals? ✓

3. Structure Drives Behavior

Blockbuster: 9,000 stores → Had to defend them → Couldn’t adapt

Netflix: No stores → Free to innovate → Could experiment

Your assets can become your prison

4. Small Changes, Big Impact

The Power of “No Late Fees”

  • Removed customer anxiety
  • Increased satisfaction
  • Enabled new usage patterns
  • Destroyed Blockbuster’s profit model

Sometimes one element changes everything

5. Disruption Starts Small

For Your Project

Think Business Model First

  1. Map the WHO-WHAT-HOW of your company
  2. Identify what’s unique about their combination
  3. Look for evolution - how has it changed?
  4. Question assumptions - what did they challenge?

Great strategies often break “industry rules”

Before Tomorrow

Essential Preparation

READ THE COLA WARS CASE

Tomorrow: How two companies
succeeded with different models
in the same industry

The End

Remember: Today’s industry giant
can be tomorrow’s cautionary tale